Tag: forecast errors

This blog has argued that Ireland should not have moved its Budget date from December to early October, as it increases the risks of forecasting errors, which history shows can be large. That was again evident in 2016, but what is also revealing, and perhaps ominous, is that the final fiscal outturn was also very different to that expected less than three months earlier, making the 2017 targets more challenging than initially thought.

The 2016 Budget envisaged the State running a current budget surplus of €0.5bn, offset by a capital deficit of €2.1bn , so leaving a borrowing requirement of €1.6bn. Current spending was projected to rise modestly, by 1.6%, and tax receipts were forecast to increase by 3.6%: Corporation tax had spectacularly exceeded the target in the previous year , by 50%, and was now expected to decline modestly. but offset by stronger tax headings elsewhere, notably from VAT, which was projected to grow by 7.7%.

As the year unfolded it became clear that tax receipts were running well above profile and by end-June were €740m or 3.4% above expectations, with corporation tax again well ahead of target, accompanied by excise duties. VAT was running behind profile but over the summer the Department of Finance projected a new tax outturn for the year, with receipts now expected to be €900m above the original figure, partly offset by higher current spending. These new projections were again reiterated in October, with the current budget surplus now expected to emerge modestly higher at €0.7bn , with the overall deficit slightly lower than originally projected, at €1.4bn.

That earlier tax buoyancy fell away in the latter part of 2016, however, and tax receipts came in over €600m ahead of the original target but well shy of the €900m overshoot pencilled in. Indeed, by end- December, most tax headings fell short of the forecasts made only a few months earler, including VAT (-210m) and Corporation tax (-€150m). Furthermore, current spending actually finished the year below the original target and a full €550m below the higher figure announced over the summer, so the government could not spend all it hoped.

Non-tax revenue also emerged well away for the revised target, this time to the upside, and the net effect was a current budget surplus of €1.3bn, some €0.8bn above the original Budget target and €0.6bn ahead of the forecast made a few months ago. The capital deficit was slighly higher than forecast, leaving an overall deficit of €1bn.

So the forecast errors in 2016, as in 2015, came in on the ‘right side’ , resulting in a smaller than expected deficit, but implying that the Government could have spent more than it had initially thought, while still hitting the fiscal targets. The forecast errors can also be on the ‘wrong side’ of course, and the 2016 outturn now means that tax receipts have to grow by 5.8% to reach the 2017 target, instead of 5.2%, with the required rise in VAT now 7.7% ( was 5.9%) and 5.0% for Corporation tax ( was 2.9%). The 2017 fiscal arithmetic therefore looks more challenging than it did when the Minister presented the Budget just a few months ago.

The last three Irish Budgets have been presented in mid-October, a departure from the previous practice of delivering them later in the year, usually in early December. The change was triggered by new Euro rules designed to improve economic surveillance (the two-pack) which stipulated that member States ‘ must publish their draft budgets for the following year’ by October 15, although budgets need not be adopted till December 31. Ireland chose to present and adopt the Budget at the earlier date although others do not pass theirs till later in the year, and there are a number of reasons why the Irish Government should consider publishing a broad outline of its fiscal targets in October but wait till December to adopt the full Budget.

Ireland’s GDP is much more volatile than the norm across developed economies, which makes for large forecasting errors in terms of economic activity and tax receipts ; the average annual forecast error for the Exchequer balance since 2000 is €1.5bn. Forecasting the following year is difficult enough in early December as the only published GDP data relates to the first two quarters of the year but at least there is some available information about the third quarter, which is not the case in mid-October.

Another factor is the November tax month, which includes income tax from the self-employed and is also a big month for corporation tax; in 2015, for example, total receipts in November were expected to be €6.5bn against a monthly average over the rest of the year of €3.3bn. Consequently, a much stronger or weaker November inflow may not only render redundant the end-year fiscal projections made in October but also compromise the forecast made for the year ahead.

The past few months has highlighted that risk in Ireland, albeit this time with the forecast errors on the positive side. The 2015 Budget projected tax receipts of €42.3bn, or 2.5% above the 2014 outturn, and it became clear as the year unfolded that economic growth was running well above expectations and tax receipts would substantially exceed the initial target, albeit largely due to a massive overshoot in one category, corporation tax. In October the Government formally revised up its tax forecast for the year, by €2.3bn to €44.6bn and announced additional spending of €1.5bn. The projected Exchequer deficit was also reduced from the initial €6.5bn to €2.8bn, reflecting unbudgeted capital receipts as well as the tax bounty. The Exchequer balance is a cash based measure and the broader General Government deficit (the preferred EU fiscal metric) for 2015 was also revised down, to 2.1% of GDP from 2.7%, with a 2016 target of 1.2%.

The November Exchequer returns have changed the picture. Receipts in the month came in at €6.9bn or €470mn above profile, leaving the overshoot year to date at €2.9bn, with corporation tax 58% or €2.3bn above expectations, a spectacular forecasting error. Spending is also still running behind the original target, so it appears unlikely the Exchequer will actually meet the higher spending figures announced in October. The net result is that tax receipts will probably end the year at €45.4bn, 10% above the 2014 outturn and €800mn above the official estimate made just six weeks ago. That and the fact that the revised spending target will not be met implies an Exchequer deficit of €1bn or less and a General Government deficit of 1.7% of GDP. Moreover,the Exchequer estimate does not include the €1.6bn payable from the partial redemption of AIB’s Preference shares so a cash surplus for the year is possible, depending on when the money is transferred,

The 2016 Budget projected a 5.8% rise in tax receipts which now implies a tax figure of €48bn next year or €0.8bn above the existing forecast, which even with the same spending targets gives a General Government deficit of 0.9% of GDP instead of the budgeted 1.2%. Of course there is no guarantee that the 2016 tax receipts will emerge on target ( particularly in relation to corporation tax) but on the face of it fiscal policy in Ireland was tighter than the authorities wanted it to be in 2015 and will now be tighter than planned in 2016. Government debt will be lower as a result on this occasion but a return to a December Budget would probably reduce the scale of forecast errors, although not eliminating them.

Ireland’s Budget for the following calendar year is now presented in early October, which increases the probability of forecast errors. Such errors are a feature of any fiscal projections but are notable in the Irish context; the median difference between the forecast Exchequer balance and the outturn over the past fifteen years is €2.5bn. This is not to put any blame on the Department of Finance or to suggest any inherent bias ( the sample is evenly split between overshoots and undershoots relative to target), but rather to highlight that errors are highly likely in an economy as volatile and open as that of Ireland, and that unexpected events can and often do materialize.

Take the 2014 budget. The fiscal projections were predicated on real economic growth of 2% , including a pick up in consumer spending and a very modest contribution from the external sector, with exports forecast to grow by 1.9%. It now seems likely that the economy grew by 5% last year , with exports growing at a double digit pace. Moreover, consumer spending growth was probably less than 1% while inflation has been much lower than forecast, although the labour market has been much firmer, with the unemployment rate averaging around 11.5% against the projected 12.4%.

The Budget arithmetic had anyway changed by the beginning of the calendar year, with debt service costs then seen to be €400mn lower than initially envisaged and revenue boosted by the full amount of receipts from the sale of the national lottery (instead of half).As a result of these factors and other changes the projected 2014 Exchequer deficit was revised down in April to €8.7bn from the original Budget target of €9.6bn

It also became clear early in the year that tax receipts were running ahead of profile and that trend continued over the course of 2014, with a final outturn €1.2bn above target; tax revenue grew by 9.2% instead of the envisaged 6%. All tax headings came in above expectations with the exception of the Local Property Tax , including a €400mn overshoot in VAT, €234mn from Corporation tax and in excess of €200mn from Stamp duty, including monies from the pension levy.

That tax oveshoot would have resulted in a deficit below €7.5bn, all else equal, but in the event the Government chose to use some of the largesse to increase spending. That decision was taken relatively late in the year as expenditure has been on or below target for much of 2014, but at end- December emerged €840mn or 2% above profile. Most of this additional outlay went on Health, which begs the question as to the realism of the original target spend for that Department.

As a consequence the Exchequer deficit for 2014 emerged at €8.2bn, above what might have been achieved but well below the original target of €9.6bn and the lowest deficit since 2007. The NTMA funded the shortfall by borrowing a broadly similar amount and used existing cash balances (i.e. previous overfunding) to repay €8.2bn to the IMF.

So one might say it turned out all right in the end but somewhat different from that envisaged when the Budget was originally delivered, an all too common experience for the Irish exchequer and one which implies it would be fruitless for Ireland to try and fine-tune economic growth via fiscal policy, even if that were possible given euro rules. On final point: the Government is now using the Irish semi-state companies (particularly the utilities) in a more aggressive way to raise revenue, with dividends received amounting to €475mn in 2014, against €264mn in 2013 and €112mn in 2012. The ESB alone ( and therefore its customers) have has contributed €840mn since 2008.